All About Taxable Income

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Saturday, August 28, 2010

Indian Finance Minister released the draft of Direct Tax Code 2009, which is expected to be effective from 1 April 2011, for public discussions on 20 August 2009. New Code shall replace India's antiquated Income Tax Act, 1961. It is a major step in the direction of much awaited tax reforms in India and aims to simplify the entire regime of taxation radically.

All the direct taxes such as income, wealth, and dividend distribution are covered under one uniform Direct Tax Code in line with other countries like USA, UK and Germany. Unlike the previous Income Tax Act, 1961, the language of the new code is very much simple, making it easier for ordinary persons to understand the provisions of Income Tax.

At present, the rates of direct taxes are declared every year while presenting the Annual Budget and Finance Act in the month of February. However, in the Direct Tax Code, the rates have already been prescribed in the various schedules and thus it has done away with the need for an annual Finance Bill. From 1 April 2011, when the new code will come into effect, the changes in the tax rates, if any, will have to be done through appropriate Amendment Bills.

Taxation Pundits are busy analysing the New Code and submitting their suggestions to the Finance Ministry. Keeping aside the expert views, let's see what are the proposed Income Tax rates for the Resident Individuals.

With the new income tax slabs, people in the higher income slab will be greatly benefited. Resident Indians who are paying tax @ 30% on gross income of more than 800,000 (as per budget 2010) will now pay tax @ 10% from 1 April 2011. Refer the rates given below to know the exact rates. Exemption limit for deductions from Income (tax incentives for savings) has been raised to 300,000 as against the present limit of Rs.100,000 under section 80C. With the widening of tax slabs, average Indians will have more disposable income and therefore it will drive the consumption and the overall economy. Please note that the new rates are likely to be implemented with effect from Financial Year 2011-2012 once the proposed Direct Tax Code 2009 is enacted in the Parliament.

Proposed Income Tax Slabs for Resident Individuals and HUF as per the Direct Tax Code 2009, likely to be effective from 1 April 2011

Taxable income up to 160,000 for men, up to 190,000 for women and up to 240,000 for senior citizens (resident individuals of 65 years or above): Tax Rate NIL

Taxable income 160,001 - 1,000,000: Tax Rate 10%

Taxable income 1,000,001 - 2,500,000: Tax Rate 20%

Taxable income 2,500,001 upwards: Tax Rate 30%

Present Income Tax Slabs for Resident Individuals and HUF as per Budget 2010, applicable for the Financial Year 1 April 2010 to 31 March 2011

Taxable income up to 160,000 for men, up to 190,000 for women and up to 240,000 for senior citizens (resident individuals of 65 years or above): Tax Rate NIL

Do you know the anatomical parts of your body? Your personal income tax return has specific parts too! For example, the first page of IRS Form 1040, also known as the "long form", has a section detailing your "diverse" sources of Income (wages, contractor fees, interest, dividends, etc.) and then a section called Adjustments. Our present tax code allows you to deduct "exceptional" expenses such as interest paid for educational loans, money "put away" for retirement funds, moving costs, alimony payments, and a part of self-employment tax. These reductions to your total reported income leave you with Adjusted Gross Income or AGI at the bottom of the first page on line 37 of your IRS Form 1040.

On the second page of Form 1040, we use your AGI, copied from the preceding page, in a new series of calculations. Additional assumptions are made about how you filed (filing status) this tax year and whether or not you supported other people in your "household". Federal tax authorities calculate a general "expense profile" that covers the entire tax year. This "profile" differs depending on your filing status (single, married filing jointly or qualified widow, married filing separately, head of household, or the special Dependent child). The general profile is listed on line 40a and called a standard deduction. It is further subdivided into basic and additional standard deduction (added for age, blindness, or both), represents the average yearly "living expense" for members of the different filing status groups. Once again, in the interest of fairness, some tax filers might NOT have life experiences that "fit" the standard "profile". For example, people who pay a mortgage for a house will typically have more expenses during the year. If a tax payer can prove (claim) that their "living expenses" exceed the amount of the standard deduction they would routinely receive, they can complete additional documentation that itemizes or lists those deductions and substitute this larger number as itemized deductions (living expenses) applied against the AGI. An adjustment for the number of people financially supported by the tax payer is yet another amount that reduces the AGI; this is separate from the standard or itemized "living expenses". Thus, a "general living expense" which includes household expenses and a supplemental amount for the number of people in the household unit reduces AGI. In other words, the number of personal exemptions is multiplied by some specific allowance ($3,650 in 2009/2010) and also deducted from the AGI to finally arrive at a Taxable Income.

There are only two events in contemporary life that a person can count on doing; paying taxes and dying. Human anatomy identifies parts of the body; bones, brain, stomach, and heart. The real story however, is in how these body parts interrelate; how, for example, a body walks, talks, eats, and, finally dies! Thus, it is true that just as anatomy is only half the story without physiology; so too is calculating taxable income, similarly, only half the process of filing a personal income tax return. We need many pages describing physiology to optimize our health and help us better understand death. We will also need many pages of tax code regulations and explanations to truly understand the best (cheapest!) ways to file our personal income tax return! Since both are inevitable; cultivating knowledge of either topic is never a waste of personal time.

Information here is offered for educational purposes; seek specific tax advice from a professional. As a freelance technical author and consultant, Phillip Schein specializes in areas that are critical for successfully running a home-based or small business. Phil has spent over 15 years in various levels of management with a background in both accounting and information technology. He has published several technical books. Originally from New York, Phil now lives in Las Vegas, Nevada because he enjoys the warm weather. One of his current business websites is http://www.sohotaxtips.com. Please contact him through his business website http://www.rainorshinesoftware.com.

Believe it or not, there are ways to convert taxable income into non-taxable income, without any fear of an IRS audit. Here's one of my favorites. It's been part of our tax code for over 30 years, yet many still don't take advantage of it.

What am I talking about? The IRA -- Individual Retirement Account.

Now, before you say, "Oh, I know all about that one; what's so great about an IRA?", give me 10 minutes to explain 3 new benefits to the IRA rules that you may not realize.

BENEFIT #1: How To Avoid Tax Rather Than Postpone Tax

First, did you know that there are now 2 kinds of IRA's available? The so-called Traditional IRA is the one that first came out way back in the 1970's. But there's a newer version of the IRA -- it's called the Roth IRA. And the difference between these 2 IRA's is huge.

Traditional IRA contributions are tax-deductible, resulting in immediate tax savings. The growth of those contributions is also tax-sheltered while the funds remain in the account.

But eventually all tax-deductible Traditional IRA contributions, as well as the growth of those contributions, will be subject to income tax when the money is withdrawn from the account. In other words, Traditional IRA's offer the opportunity to temporarily postpone taxes.

In contrast, the Roth IRA offers the opportunity to permanently avoid taxes. With a Roth IRA, you don't take a deduction for your contributions; instead, you make a contribution with "after-tax" dollars. Whatever you put in not only grows tax-free, but can also be withdrawn tax-free.

Here's an example to illustrate: If you invest $2,000 per year for 20 years into a Roth IRA, you will have invested a total of $40,000. Now if that Roth IRA earns an average of 5% per year (compounded monthly), that $40,000 will grow to about $68,000.

Now comes the fun part: Assuming the IRA has existed for at least 5 years and you are at least 59 1/2 years old, you can withdraw the entire $68,000 tax free. In contrast, if this money had been invested in a Traditional IRA, the entire $68,000 would be subject to income tax as it is withdrawn.

In the Roth IRA, the $28,000 of growth is magically converted from taxable income to non-taxable income. Assuming you are in the 15% federal tax bracket, that's a savings of $4,200.

BENEFIT #2: Take An Extra 3 1/2 Months To Fund Your IRA

The deadline for contributing to your IRA is April 15 of the year AFTER the year for which the contribution made. So for Year 2008, you have until April 15, 2009 to put money into your IRA.

If you've already invested the maximum (more about that in a moment) by December 31, 2008, then you're done. No more money can go into the IRA for 2008. But if you haven't maxed out your IRA, you have until April 15 to do so.

Which brings me to...

BENEFIT #3: The Maximum Contribution Amounts Have Increased

For many years, the most you could put into an IRA was $2,000. Now, the maximum is $5,000 (assuming you have at least that much earned income from wages, salary or self-employment income). And if you are over 49, you can put in another $1,000, bringing the total maximum to $6,000.

A married couple, both age 50 or older, can put a whopping $12,000 per year into a IRA. Not too shabby, eh?

One final note about these Roth IRA rules: For married people, you can only contribute the maximum of $5,000 or $6,000 if your 2008 combined income is less than $159,000. If you are single or head of household, you can contribute the maximum if your 2008 income is less than $101,000.

For most middle-class folks looking for a perfectly legal way to permanently avoid tax (rather then merely temporarily postpone tax), the Roth IRA fits the bill.

Wayne M. Davies is author of 3 ebooks on tax reduction strategies for small business owners and the self-employed. For a free copy of his Special Report "How To Instantly Double Your Deductions", visit http://www.YouSaveOnTaxes.com

You have just spent a relaxing time with your family in your favourite holiday destination, and you are thinking, wow this would be an ideal place to purchase a holiday home for future vacations and as an investment for retirement. To offset the expenses of running your holiday home, your plan is to have the holiday home available for rent for most of the year and use the home for your holidays for some of the year.

How does the Australian Taxation Office deal with a situation like this, do they allow you to claim any deductions against the holiday home rental income?

First we should look at what is assessable income. Renting your holiday home to family and friends at a minimal cost isn't considered assessable income as it is merely reimbursing you for out of pocket expenses. The rent received via commercial renting on the other hand is assessable income. The next question, how are the expenses offset against the assessable income?

As with all tax deductions, the Australian Taxation Office requires that the personal use of a deduction can not be claimed. Clearly using the property for yourself and letting your family and friends use it at none commercial rental rates is personal use. Therefore no deductions are allowed for the property's expenses for these periods.

So, what you use and what friends and family use is not tax deductible, therefore the expenses for the rest of the year are tax deductible, well, no its not quite that simple. What you now need to prove is that you are actually trying to rent the property out, this will need to be done by going through a property agent, or maybe listing on an internet holiday rental web site. The more that you can show that you are actively finding a tenant the more likely you will be able to claim the deductions for the property.

In one year if you personally use the property for say 6 weeks and actively look for tenants for the remainder of the year, then you can claim 46/52 of your deductions for the property. Also bear in mind that while you are actively looking for tenants it doesn't mean that your property needs to be tenanted 100% of the time.

Saturday, August 21, 2010

By George BauernfeindIn Part I, we discussed the different tax brackets for the Regular Tax and for the Alternative Minimum Tax, as well as the AMT exemption. For 2009 for married couples filing jointly (MFJ) the AMT exemption was $70,950. In this article we will discuss the phase-out, or loss, of the exemption as taxable income exceeds a certain threshold level. For MFJ, this taxable income threshold is $150,000. The Form 6251 also has the thresholds for the other filing statuses, found at the IRS website.

The AMT exemption phase-out

As taxable income increases above $150,000, the AMT exemption amount decreases. A taxpayer loses $1 of exemption for every $4 increase in taxable income. Thus, for example, if taxable income before exemption is $250,000 ($100,000 over the threshold), $25,000 of the AMT exemption is lost. All other things being equal, in this example AMT taxable income would be $275,000 even though Regular Tax taxable income would be $250,000 - making it likely you would find yourself stuck in the AMT.

Note that this phase-out formula means your AMT taxable income increases at a more rapid rate - 25% faster - than any increase in your Regular Tax taxable income. This acceleration is a significant part of what pulls individuals quickly into the AMT.

Dividends and capital gains

Under current law, dividends and long-term capital gains are taxed at a lower bracket - typically 15% - for both the Regular Tax and for the AMT. In theory, using this same bracket prevents dividends and capital gains from triggering the AMT.

Unfortunately, however, dividends and capital gains are included as part of taxable income, so they, like all other income, have a direct impact on an individual's AMT because of the extra 25% effect discussed above. It's easy to be fooled by this one.

Beyond the AMT exemption phase-out

For taxpayers who make "a lot" of money (defined below), the AMT rapidly becomes much less of a concern. There are two forces at work here as income gets into higher levels:

First is that the AMT exemption phase-out simply stops at a certain point. For MFJ, the phase-out stops at taxable income of $433,800. At this point, the $283,800 of income over the initial $150,000 means (at the 4-to-1 ratio described above) the $70,950 exemption is completely gone ($70,950 times 4 equals $283,800). After this, AMT income grows at the same rate as does Regular Tax taxable income, so the 25% penalty no longer applies.

Second is that, at this level of income, the taxpayer now is paying Regular Tax at a significantly higher bracket than the AMT bracket. Looking at the above tax bracket schedules, one can see that the taxpayer now is well into the 35% Regular Tax bracket, leaving far behind the maximum 28% AMT bracket. Remembering that a taxpayer pays the greater of the Alternative Minimum Tax or the Regular Tax, at these levels of income it is unlikely the taxpayer will be in the AMT.

Summary

Once a MFJ couple exceeds the $150,000 taxable income level, the sucking sound of the AMT vortex pulls them in at a rapidly-increasing rate. But for the wealthy - ironically, those at whom the original Minimum Tax was aimed when it was first enacted over 40 years ago - they can safely sit on the sidelines and not even be concerned. This is why, in the tax returns disclosed in the 2008 Presidential campaign, we saw that Joe Biden, John McCain and Sarah Palin - each making in the neighborhood of $250,000 - all were caught in the AMT trap, while President Obama with his millions from book royalties was not even touched by it.

George Bauernfeind is with AMTIndividual.com, providing analysis, customized strategies, and an online dual tax calculator / planner to help you reduce your Alternative Minimum Tax. Visit http://amtindividual.com or http://amtblog.com for access to this tax software and to read more tax planning articles on the Alternative Minimum Tax.